Tag Archives: #dollarup

Nowhere Near

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Charles Evans, on Tuesday, explained
Inflation can well be contained
In fact, his concern
Is prices could turn
Back lower ere targets are gained

“I’m going to be very regretful if we sort of claim victory on averaging 2% and then we find ourselves in 2023 with about a 1.8% inflation rate, sustainable, going forward. That would be a challenge for our long-run framework,” he [Evans] said. “We ought to be willing to average inflation above 2%—frankly, well above 2%. [author’s emphasis]”

One cannot overstate the hubris associated with the above quote from Chicago Fed President Charles Evans.  The fact that he legitimately believes the Fed’s powers are such that they can fine-tune a $24 trillion economy to the point that measured estimates of particular features of that economy are able to be managed to a decimal place of an annualized percentage outcome is extraordinary.  It is the perfect illustration of the fact that the Fed is completely out of touch with the economy in which you and I live and completely ensconced in a model driven framework where data represents reality.  But it is exactly this hubris that has resulted in the policy decisions that have brought the world negative interest rates and a defense of debt monetization.  As long as central bankers, notably the Fed, continue to believe that their models are the economy, rather than a simplified representation of the economy, they are likely to continue to make decisions with significant unintended consequences from which we all will suffer.

This morning the market awaits
The latest inflation updates
What’s patently clear
Is they’re nowhere near
An outcome to end the debates

Speaking of inflation, this morning brings the latest CPI data with expectations running as follows: Headline (0.5%, 5.3% Y/Y) and ex food & energy (0.4%, 4.3% Y/Y).  Both of those forecasts are slightly lower than the prints seen in July, and if realized, you can be sure that we will hear a chorus of FOMC members highlighting the transitory nature of inflation.  Of course, if the outcomes are higher than forecast, something we have seen in each of the past twelve reports, we will also hear a chorus of FOMC members explaining that this remains a temporary phenomenon and that inflation is transitory.  [Perhaps when Ralph Waldo Emerson wrote in 1841, “a foolish consistency is the hobgoblin of little minds, adored by little statesmen and philosophers and divines,” he was anticipating the Fed.]  However, financial markets may not be quite as sanguine over the results, especially if they continue their year-long streak of outperforming the median estimate.

Markets, of late, have been starting to discern between those products that will benefit from altered policy and those products that will suffer.  Nowhere is this clearer than in the US equity markets where we have seen the NASDAQ underperform its brethren indices.  Recall, given the NASDAQ’s strong bias toward high growth (and low profit) companies that benefit greatly from extremely low interest rates, the index behaves very much like a very long-duration bond.  So, in a scenario where inflation is rising and market expectations are for tapering of asset purchases to begin soon(ish), it should be no surprise that the NASDAQ falls alongside the price of bonds.  At the same time, if the implication is that rising inflation is being caused by rebounding growth, rather than supply-chain blockages, there is an opportunity for more mundane, value-type companies to outperform.  Hence, the differing performance of the DOW vs. the NASDAQ.
Of course, the place where inflation is likely to have the most direct effect is the bond market, where long-term yields are theoretically supposed to reflect inflation expectations.  And while we have certainly seen yields rise over the past week, there is no way they currently reflect those expectations.  They cannot do so as long the Fed continues to buy all the new issuance, and then some, thus artificially driving up prices and driving down yields.  Ask yourself this, does it make sense that US 10-year yields are at 1.36% if inflation is at 5.4%?  Of course, the answer to that is a resounding ‘No!’  Yet, that is the current situation.  To observe the bond market and believe it is not artificially inflated (everywhere in the world, mind you) is akin to believing that the moon is made of green cheese.  It just ain’t so!

At any rate, ahead of this morning’s CPI release, investors have generally been biding their time as they wait to determine if they need to adjust their world view.  Equity markets are generally a bit firmer as Asia mostly eked out some gains (Nikkei +0.6%, Hang Seng +0.2%, Shanghai 0.0%) with Europe following suit (DAX 0.0%, CAC +0.3%, FTSE 100 +0.5%).  US futures are split with the NASDAQ (-0.2%) slipping following yesterday’s losses, while the other two main indices are essentially unchanged.  All in all, it appears that there is some hope that CPI prints on the low side to allow the Fed narrative to continue apace, and therefore to allow rates to remain lower for longer.

Bond markets, though, are starting to get a bit antsy these days with Treasury yields edging higher again (+1.7bps) with similar type gains seen throughout Europe (Gilts +1.4bps, OATs +1.8bps, Bunds +0.8bps).  At this point, 10-year Treasury yields have risen 0.25% in the space of a week, which is a very substantial move, especially when considering that the base at the beginning was just 1.12%.  One has to believe the Fed is watching extremely closely as they do not want to see the market run too far ahead of their mooted tapering and create Taper tantrum #2 inadvertently.  It is here where a higher than forecast CPI print could have quite an impact and which may force the Fed to reconsider the idea of tapering.  After all, they cannot afford for 10-year yields to rise to 2.0% while they are still purchasing $120 billion per month of paper.

Commodity prices are mixed today with oil (-1.1%) feeling the pressure of higher yields while gold (+0.5%) seems to be ignoring that same pressure.  Of course, gold was just subject to a significant sell-off, so this could easily be a simple trading bounce.  As it happens, both agricultural and base metal prices are showing a mixture of gainers and losers and no real underlying theme.

Finally, the dollar is definitely stronger again this morning.  While the movement vs. its G10 brethren has not been large, it is unanimous, with all currencies in the red today.  A particular shout-out goes to the euro, which is trading just pips from the key support level of 1.1704.  Watch that carefully as a break there is likely to open up much lower levels.  In the emerging markets, KRW (-0.6%) has been the laggard, followed by TRY (-0.5%) and HUF (-0.4%).  The won has been suffering from a combination of rising covid cases, with a record high 2200 reported yesterday, which has been encouraging the liquidation by foreign investors of Korean equities.  Meanwhile, TRY is under pressure as traders are concerned the President Erdogan will once again interfere in the central bank’s business and prevent them from raising rates at tomorrow’s meeting.  Finally, the forint seems to be suffering for the sins of its neighbors as concerns over German growth, a key market, and Polish politics, a close neighbor, have encouraged selling.

And that’s really it for today.  All eyes will be on the CPI at 8:30. More than just watching the tape, I always pay attention to @inflation_guy on Twitter as he does an excellent job breaking down the drivers of the number and offering insight into how things may evolve.  I highly recommend following him.

As to the dollar, the slow grind higher continues and as long as US rates are rising, I think so will the dollar.  If we break the 1.1704 level in the euro, look for a bit of an acceleration.  But don’t be surprised if we reject the move given it is the first test of the support level since it was established back in March.

Good luck and stay safe
Adf

The Chorus has Grown

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T’was only a few months ago
When Kaplan from Dallas said, whoa
The time has arrived
Where growth has revived
And bond buying needs to go slow

Since then, though, the chorus has grown
As seven more members have shown
That they all agree
It’s time for QE
To end and leave markets alone

We continue to hear from more FOMC members that it is time to taper the Fed’s purchases of both Treasuries and mortgage-backed securities.  Last Wednesday, of course, the big news was that Vice-Chairman Richard Clarida came out so hawkishly in his comments, not only calling for tapering bond purchases but also raising rates sooner than the median forecast had anticipated.  Yesterday, three Fed speakers were all on the same page, with Boston’s Eric Rosengren the newest name added to the tapering crew (Bostic and Barkin were already known taperers.)  That takes the count to at least eight (Clarida, Bostic, Barkin, Rosengren, Bullard, Daly, Waller and Kaplan) with the two most hawkish FOMC members, Loretta Mester and Esther George, on the docket for today and tomorrow respectively.  It is not unreasonable, based on their respective histories, to expect both of them to call for tapering as well.  That would make ten of the seventeen members as confirmed supporters of the process.

The question is, will that be enough?  The Fed’s power core for the last several years has been concentrated in four members, Powell, Clarida, Williams and Brainerd.  Of this group, only Clarida has publicly proclaimed it has come time to taper.  And potentially, his importance is diminishing as his term ends within months and he is seen as highly unlikely to be reappointed.  Rather, the talk of the town is that Chairman Powell is also losing fans in the Senate with respect to his reappointment, and that Governor Lael Brainerd is the new leading candidate to become Fed Chair.  As it happens, neither of those two have come out for tapering soon, and in fact, last week, Ms Brainerd was adamant in her belief it was far too early to do so.  The point is, the Fed has never been a democratic institution although it is an extremely political one.  Having a majority of members agree on a view only matters if it is a majority of the right members.  By my count, that is not yet the case.  Perhaps come Jackson Hole in two plus weeks, we will hear the Chairman agree, but tapering is not yet a done deal.

Traders, however, see the world very differently than pundits, and certainly very differently than the Fed itself.  And what has become very clear in the past several days is that traders are increasingly placing bets that tapering is coming…and coming soon.  The combination of all those Fed speakers talking about tapering, the very strong NFP data as well as yesterday’s JOLTs blowout (>10 million jobs are open), and the constant stream of stories about rising wages (just this morning a BBG story on JPM raising salaries to compete to hold onto staff is simply the latest) have been sufficient to logically conclude that it is time for the Fed to begin removing accommodation.  Hence, Treasury yields have backed up nearly 20 basis points from the lows seen last Wednesday morning, the dollar has risen against all its counterparts and the price of oil has fallen by more than 4%.

Looking ahead, the question becomes, is this likely to continue?  Or have we reached a peak?  It is not unreasonable to assume that both George and Mester will call for tapering this week.  It is also not unreasonable to assume that the CPI data tomorrow is going to point to a still rising price environment, whether it ticks slightly higher or lower than last month’s 5.4% headline print.  Any number in that vicinity remains far above the Fed’s average target of 2.0%.  The point is that there is nothing obvious on the horizon that should cause the tapering hawks to back off, at least not until the end of the month.  As such, hedgers need to be prepared for a continuation of the recent price action.

Meanwhile, a look at today’s markets shows that these recent trends remain intact.  While Asian equity markets continue to follow their own drummer (Nikkei +0.25%, Hang Seng +1.25%, Shanghai +1.0%), European bourses continue to struggle (DAX +0.2%, CAC +0.1%, FTSE 100 -0.1%) as do US futures with all three major indices either side of unchanged.  Asia seems to be benefitting from the view that the PBOC is preparing to ease policy further as China responds to the increased lockdowns due to the delta variant of Covid that has been spreading quite rapidly there, in addition to the fact that the Chinese authorities have not named a new target in its seemingly random crackdown of successful companies.

Bond markets, while edging higher today, have been generally losing ground.  So, while Treasury yields are lower by 0.5bps this morning, they are at 1.32%, well off the lows seen last week.  European sovereigns are generally a touch firmer as well, with yields down by between 0.5bps and 1 bp but they, too, have seen yields climb back a bit lately.

Commodity prices, which have been under severe pressure, are rebounding slightly this morning, although this has the appearance of a trading bounce more than a sea change in view.  Commodity prices are likely to be amongst the hardest hit if the Fed really does start to tighten policy.  But this morning, oil (+2.0%) has rebounded nicely although gold (0.0%) has been unable to bounce from yesterday’s massive sell-off.  Copper (+0.65%) is leading base metals modestly higher and ags have bumped up a bit as well.

As to the dollar, right now it is arguably slightly stronger overall, but only just as there are a mix of gainers and losers vs. the greenback.  In the G10 space, the euro (-0.1%) is continuing toward its test of key support at 1.1704, albeit quite slowly.  The entire space, though, is +/- 0.2% or less, which is indicative of position adjustments rather than news driven activity.

EMG currencies are also mixed with KRW (-0.5%) the weakest of the bunch on the back of concerns over the impact of the delta variant as well as equity market outflows by international investors.  PLN (-0.4%) is the next weakest as central bank comments seemed to delay the timing of a mooted rate hike.  On the flip side, TRY (+0.6%) is the leader as Unemployment data there was released at a much lower than expected 10.6%.

Data today showed that Small Business Optimism has suffered lately with the NFIB Index falling to 99.7.  At 8:30 we see Nonfarm Productivity (exp 3.2%) and Unit Labor Costs (+1.0%), although it is unlikely either will have a big market impact.  Arguably, market participants are all waiting for tomorrow’s CPI data for the next big piece of news.

At this point, the dollar’s modest uptrend remains in place and I see no reason to believe that will change.  At least not until we hear differently from Powell or the data turns much worse.

Good luck and stay safe
Adf

A New Endeavor

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A trend that is growing worldwide
Shows policy’s been modified
From lower forever
To a new endeavor
That tapering must be applied

But what if the jobless report
Frustrates and the number falls short?
Will traders respond
By buying the bond?
Or will sellers keep holding court?

While today is a summer Friday, which typically holds little excitement except for the anticipation of the weekend, there is a bit more at stake this morning with the release of the July NFP report at 8:30.  Given that we appear to be reaching an inflection point in policymaking circles, today’s data could either cement the changes that seem to be coming, or it could throw cold water on the entire process and take us back to square one.

The one thing that we have heard consistently over the past several weeks is that there is a growing desire by a widening array of FOMC members to begin tapering asset purchases.  While Chairman Powell has not yet indicated he is ready, and a key lieutenant, Governor Lael Brainerd, was forceful in her views that it was way too early to do so, at least six or seven other members are ready to roll, with the latest being vice-chair Clarida and SF President Daly.  But all of this tightening talk is predicated on the idea that not only has the inflation part of their mandate been achieved (gotten out of hand really), but that they have made progress on the employment part.

This brings us to today’s report.  Since December, when the number was negative amid the second wave of the Covid outbreak, we have seen the following numbers: 233K, 536K, 785K, 269K, 583K, 850K. Historically, all of those numbers would be seen as strong, but obviously, given the 20 million job losses at the beginning of the lockdown last year, those numbers represent a very different situation now.  A rudimentary look at the pattern would have you believe that today’s print, expected at 858K, is more likely to come at a much lower number, something like 250K-300K.  Frankly, the thing that has me concerned is that the monthly survey is taken during the week that contains the 15th of the month.  A quick look back at the weekly Initial Claims data for that week in July shows it was a surprisingly high 424K, a relatively high level given the prior trend.  So, it could well be that a quirk in the data may result in a disappointing headline number.  Remember, too, that the ADP Employment number was a MUCH weaker than expected 330K, so another potential sign of impending weakness.  My point is that there is a very real opportunity for a negative surprise this morning.

The question is; if we do get a negative surprise, will markets ignore it?  Or will they reevaluate their current belief set that tapering is on the way?  As it happens, there are no Fed speakers scheduled for today, so it is not obvious that anyone will be able to clarify things in that situation.

Ahead of the number, markets continue to demonstrate their belief that tighter monetary policy is coming to the US.  This is made evident by the dollar’s continuing strength, with the euro (-0.25%) testing the 1.18 level and stronger vs. all of its G10 and most of its EMG counterparts.  It is evident in the continued backing up in Treasury yields, which after trading as low as 1.1275% Wednesday ahead of the Clarida comments, are now higher by 3.3 basis points this morning and trading back at 1.26%.  While this is hardly “high” in a broad sense, the recent movement does demonstrate a clear trend

Equity markets seem to be somewhat less concerned, as yesterday, once again, US markets traded to new all-time highs.  European markets are all modestly in the green this morning and only China, which continues to attack its own companies (the latest being Moutai, the food delivery service that is mooted to be fined >$1 billion for no apparent reason), has seen any real weakness in this space.  But equity investors will continue to claim TINA until yields have really made a comeback.  And despite the modest declines we have seen in bond prices today, we have actually seen negative yielding debt rise further, to $16.9 trillion, as of yesterday, hardly a sign of tighter policy.

So, overall, we are mostly given mixed signals by markets and policymakers and need to sort things out for ourselves.  The first thing to do is look at what is expected this morning

Nonfarm Payrolls 858K
Private Payrolls 709K
Manufacturing Payrolls 26K
Unemployment Rate 5.7%
Average Hourly Earnings 0.3% (3.9% Y/Y)
Average Weekly Hours 34.7
Participation Rate 61.7%
Consumer Credit $23.0B

Source: Bloomberg

Between the widening spread of the delta variant, which is clearly disrupting supply chains around the world as well as causing more lockdowns and thus slowing economic activity, and the statistical noise and patterns, I have a feeling we are going to get a pretty bad number.  A print below 500K, which is my guess, is likely to force at least some rethinking of the timing for tapering.  Remember, while the Fed has admitted that some progress toward their goals has been achieved, their standard of “substantial further progress” remains “a ways away” according to Chairman Powell’s last comments.  A low print today will certainly delay the tapering talk.

In that event, how can we expect markets to respond?  Well, as the equity market sees all news as good news, it will clearly rally under the guise of easy money for longer.  Bond markets are also likely to push higher with yields slipping as concerns over a taper in the near-term dissipate.  But arguably, the biggest mover will be the dollar, which I believe has rallied sharply on the tapering talk, and if/when that fades, the short-term case for being long dollars will fade with it.

If I am wrong, and we get a strong number then the taper talk will intensify.  This should lead to further bond weakness (higher yields), a dollar rally and likely test of the key euro support at 1.1704, and … an equity rally since that is what stocks seem to do.

Good luck, good weekend and stay safe
Adf

Dire Straits

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The Vice-Chair explained he foresees
A time when the Fed, by degrees
Will taper their buying
Of bonds while they’re trying
To offset the spread of disease

Soon after they finish that deed
Most members already agreed
To raise interest rates
Unless dire straits
In markets don’t let them succeed

Fed Vice-Chair Richard Clarida certainly surprised markets yesterday with his speech as he laid out his reasoning that the tapering of the Fed’s current QE purchases will occur sooner than many had previously expected.  While he started out with the caveat that the Fed will not be responding to forecasts, but rather to actual economic outcomes, he then proceeded to forecast the exact sequence of events that will occur and create the proper environment for the Fed to first, taper bond purchases and second, eventually raise interest rates.  The market response was immediate, with the bond market selling off sharply, the dollar rallying and equity markets ceding early gains alongside most commodity prices.  After all, a tighter Fed is not nearly as supportive of risk assets, but neither does it imply lower interest rates.  It is also worth noting that coincident with the release of the text of his speech was the release of the ISM Services number which printed at a much higher than expected, and record level, 64.1.  So, a positive data print and a hawkish Fed speaker were sufficient to change a lot of opinions.

But not this author’s, at least not yet.  My baseline view continues to be that the Fed remains in an extremely difficult position where inflation continues at much higher levels than which they expected or with which they are comfortable, but the employment market remains far away from their restated goal of maximum employment.  As well, as Clarida noted yesterday, and as has been repeated by numerous other Fed speakers, they promise they are not going to move on forecasts or survey data, but instead wait for actual numbers (read the NFP data and core PCE) to achieve their preferred levels before altering policy.  This means that tomorrow’s NFP data will be scrutinized even more closely than usual, as Clarida’s comments yesterday imply that even more FOMC members are ready to move.

One problem with the early taper thesis is that the data may not meet the FOMC’s requirements, at least not in the near term.  For instance, yesterday’s ADP Employment release printed at 330K, less than half the expected 690K and basically one-third of the forecasts for NFP tomorrow.  While the month to month correlation between the two data points is not perfect (0.784 over the past 5 years) it is certainly high enough to imply a strong relationship between the two.  The point is that if tomorrow’s NFP number disappoints, which cannot be ruled out, and assuming that the Fed is true to their word regarding waiting for actual data to reach their preferred levels, it would certainly suggest a delay to the tapering story.  Keep in mind, as well, that the Citi Economic Surprise Index, which measures actual releases vs. forecasts, remains in negative territory, implying that the economy is slowing further rather than extending gains seen earlier in the year.  In fact, after the much worse than expected GDP print last week, it appears that growth is already slipping back toward pre-Covid trends of 1.5% – 2.0%.  Oh yeah, none of this includes the impact of the delta variant, which has resulted in numerous lockdowns around the world and augers still slower growth.

On the flip side, though, is the fact that we have seen an increasing number of FOMC members start to accept the idea that tapering will soon be appropriate.  In addition to Clarida, yesterday we also heard from SF Fed President Daly, an avowed dove, who said, “Fed will do something on asset purchases end ’21 / early ’22.”  By my count, that makes at least six different FOMC members who have indicated tapering is coming soon.  Of this group, Clarida is by far the most important, but if even the doves like Daly are coming round to that view, tapering cannot be ruled out.

To taper or not remains the $64 trillion question for all markets, and while the recent trend of the narrative seems to be pushing in that direction, without support from ongoing improvements in employment data (after all, inflation is well through their target), it will still come to naught.

One last thing on inflation.  As the Fed tries to retake the narrative from the market, be prepared for a new description of inflation.  No longer will it be transitory, but rather, perhaps, tolerable.  In other words, they will accept that it is running hotter than their target and make the excuse that it is far more important to get the nation back to work first, at which point they can use those vaunted tools they frequently mention to address rapidly rising prices.

With all this in mind, the next question is, how will these changes impact the markets?  Yesterday’s price action is likely to be a very good case study if the data continues to support an early tapering of purchases.  Any interruption in the flow of money into the capital markets will be felt by both equities and bonds in the same way, they will fall in price, while the dollar is very likely to find a lot of support vs. both G10 and EMG counterparts.  As to commodities, my inclination is that the past year’s rally will pause, at the very least, but given they remain massively undervalued vs. other asset classes, they likely still have some upside.

On to today.  Overnight price action was mixed with the Nikkei (+0.5%) rising somewhat while Chinese shares (Hang Seng -0.8%, Shanghai -0.3%) were under pressure as stories about the next sectors to feel the wrath of regulators (sin stocks) were rampant with those falling and dragging the indices with them.  fortunately, they represent a much smaller portion of the market than the tech sector, so will have a smaller negative impact if that is, indeed, the situation.  Europe is mixed this morning (DAX +0.1%, CAC +0.35%, FTSE 100 -0.2%) as the morning data was inconclusive and investors there are far more concerned with the Fed than anything else.  As to US futures, they are all modestly higher this morning, about 0.2%.

Bond markets are showing the difference between central bank policy this morning with Treasuries consolidating yesterday’s declines and unchanged on the day, while European sovereigns (Bunds -1.0bps, OATs -1.2bps) continue to see support from an ECB that is nowhere near tightening policy.  Gilts (+2.0bps) on the other hand, are selling off a bit as the BOE meeting, just ending, revealed several things.  First, they are prepared to go to negative interest rates if they need to.  Second, they will continue their current QE pace of £3.4 billion per week, and third, that they expect inflation to reach 4.0% in Q4 of this year.  They did, however, explain that if things proceed as expected, some tightening, read higher interest rates, may be appropriate.  while the initial move in the GBP was a sharp jump higher, it has already retraced those steps and at +0.2% is only modestly up on the day.

Commodity prices are mixed with oil consolidating after yesterday’s rout and unchanged on the day.  In fact, the same is true of precious and most base metals, as traders are trying to figure out their next move, so likely waiting for tomorrow’s data.

And the dollar, interestingly, is modestly softer vs. the G10 this morning, but that is after a strong rally yesterday in the wake of the Clarida speech.  The commodity bloc is leading the way (AUD +0.35%, NOK +0.3%, NZD +0.25%) despite the lack of commodity price action.  And this also sems to ignore the 6th lockdown in Melbourne since the pandemic began last year, as the delta variant continues to wreak havoc around the world.  The rest of the G10 though, has seen much less movement.  In the emerging markets, PHP (-1.0%) was by far the worst performer overnight as the covid caseload soared to record numbers and concerns over growth expanded.  After that, TRY (-0.6%) is the next worst, as President Erdogan came out with calls for a rate cut despite rampant inflation.  However, away from those two currencies, movement has been on the order of +/- 0.2%, indicating nothing very special.  Essentially, these markets have ignored Clarida.  One last thing to note here is yesterday, the central bank of Brazil raised its SELIC rate by 1.0% to 5.25%, as inflation is exploding there.  However while BRL has been modestly stronger over the past several sessions, this was widely priced in so there was no big movement.

Data-wise, today brings Initial Claims (exp 383K), Continuing Claims (3255K) and the Trade Balance (-$74.2B), none of which seem likely to change any opinions.  Rather, at this point, all eyes are on tomorrow’s NFP data.  We also hear from two Fed speakers, Governor Waller and Minneapolis President KashKari, who is arguably the most dovish of all.  certainly if he starts talking taper, then the die is cast.  We shall see.

As I said, if tapering is on the cards, the dollar will likely test its highs from March/April, so be prepared.

Good luck and stay safe
Adf

Tougher for Jay

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The Fed once again will convey
Inflation just ain’t here to stay
But every release
That shows an increase
Makes life that much tougher for Jay

Meanwhile, Chinese comments last night
Explained everything was alright
They further suggested
That more be invested
To underscore risk appetite

As we await the FOMC meeting’s conclusion this afternoon, markets have generally remained calm, even those in China.  Apparently, 20% is the limit as to how far any government will allow equity markets to decline. After three raucous sessions in China and Hong Kong, as investors fled from those companies under attack review by the Chinese government for their alleged regulatory transgressions, the Chinese press was out in force explaining that there were no long term problems and that both the economy and stock markets were just fine and quite safe.  “Recent declines are unsustainable” claimed the Securities Daily, a state-owned financial paper.  We shall see if that is the case, especially since there is no indication that the government has finished its regulatory crackdown across different industries.

However, the carnage of the past several sessions was not evident last night as the Hang Seng (+1.5%) rebounded nicely while Shanghai (-0.6%) managed to close 1.5% above the lows seen early in the session.  It hardly seems coincidental that the Chinese reacted to the declines after a 20% fall as that seems to be the number that defines concern.  Recall, in Q4 2018, Chairman Powell, who had been adamant there were no issues and was blissfully allowing the Fed’s balance sheet to slowly shrink while simultaneously raising interest rates made a quick 180˚ turn on Boxing Day when the S&P’s decline had reached 20%.  It seems that no central banker or government is willing to allow a bear market on their watch, even those that need never face the voters.

While forecasting the future is extremely difficult, it seems likely that if President Xi turns his sights on another industry, (Real Estate anyone?) then we could easily see another wave lower across these markets.  While instability is not desired, when push comes to shove, Xi’s ideology trumps all other concerns, and if he believes it is being threatened by the growth and power of an industry, you can be certain that industry will be targeted.  Caveat investor!

As to the Fed, the universal expectation is there will be no policy changes, so interest rates will remain the same and the asset purchase program will continue at its monthly pace of $120 billion.  The real questions center around tapering (will they mention it in the statement and how will Powell address it in the press conference) and the nature of inflation.  While clearly the latter will be described as transitory, will there be some acknowledgement that it is running hotter than they ever expected?

At Powell’s Congressional testimony several weeks ago, he was clear that “substantial further progress” toward their goals of maximum employment and average inflation stably at 2.0%, had not yet been made.  Has that progress been made in the interim?  I think not.  This implies, to me at least, that there is no policy change in the offing for a long time to come.  While there are many analysts who are looking for a more hawkish turn from the Fed in response to the clearly rising price pressures, the hallmark of this (and every previous) committee is that they will stick to their narrative regardless of the situation on the ground.  I expect they will ignore the much higher than expected inflation prints and that when asked at the press conference, Powell will strongly maintain inflation is transitory and will be falling soon.  Monday, I explained my concern that CPI is likely to moderate for a short period of time before heading sharply higher again, and that Powell and the Fed will take that moderation as victory.  Nothing has changed that view, nor the view that the Fed will fall far behind the curve when it comes to fighting inflation.  But that is the future.  For now, the Fed is very likely to remain calm and stick to their story.

OK, with that out of the way, we can peruse the markets, which, as I mentioned above, have been vey quiet awaiting the FOMC.  The other key Asian market, the Nikkei (-1.4%) fell overnight after having rallied during the Chinese fireworks, as the spread of the delta variant of Covid-19 and ongoing lockdowns in Japan have started to concern investors.

Europe, on the other hand, is all green on the screen led by the CAC (+0.75%) with both the DAX (+0.2%) and FTSE 100 (+0.2%) up similar but lesser amounts.  You’re hard pressed to point to the data as a driver as the little we saw showed German Import prices rise 12.9%, the highest level since September 1981, while French Consumer Confidence fell a tick to 101.  Hardly the stuff of bullish sentiment.  US futures, currently, sit essentially unchanged as traders and investors await Powell’s pronouncements.

The bond market is mixed this morning, with Treasury yields edging higher by 1 basis point while most of Europe is seeing a very modest decline in yields, less than 1bp.  Essentially, this is the price action of positions being adjusted ahead of key data.

Commodity prices show oil rising (+0.5%) but very little movement anywhere else in the space with both metals and agricultural prices either side of unchanged on the day.

Lastly, the dollar is ever so slightly stronger vs. most G10 counterparts, with AUD (-0.25%) and NZD (-0.2%) the laggards as concern grows over the economic impact of the ongoing spread of the delta variant.  CAD (+0.25%) is the one gainer of note, seemingly following oil’s lead.  EMG currencies have had a more mixed session with KRW (-0.4%) the worst performer on the back of rising Covid cases and ongoing concerns over what is happening in China.  The only other laggard of note is HUF (-0.3%) which is still suffering from its ongoing political fight with the EU and the result that EU Covid aid has been indefinitely delayed.  On the plus side, RUB (+0.35%) is following oil while CNY (+0.2%) seems to be benefitting from the calm imposed on markets last night.  Otherwise, movement in this space has been minimal.

All eyes are on the FOMC at 2:00 this afternoon, with only very minor data releases before then.  My read is that the market is looking for a slightly hawkish tilt to the Fed as a response to the rapidly rising inflation.  However, I disagree, and feel the risk is a more dovish than expected outcome. The fact that US economic data continues to mildly disappoint will weigh on any decision.  If I am correct, I think the dollar will have the opportunity to sink a bit further, but only a bit.

Good luck and stay safe
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A Small Crisis Grows

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Investors are starting to feel
That China has lost its appeal
So, capital flees
From all stocks, Chinese
As Xi brings exploiters to heel

While, thus far the impact’s been small
On markets elsewhere, please recall
That history shows
A small crisis grows
Quite quickly with each margin call

Giving credit where it is due, the Chinese have successfully distracted almost every market participant from tomorrow’s FOMC meeting.  The ongoing rout in Chinese equity markets (Shanghai -2.5%, Hang Seng -4.2%) has been fueled by the government’s hardline stance against several different industries that had become investor favorites.  If you think of the progression of events, it began with private financial firms (remember the Ant IPO that was squashed when Jack Ma was disappeared for a while?) and has continued as the evolution of the DC/EP (China’s digital yuan or CBDC) has forced the two big private payment firms, Alipay and WeChat Pay to fall into line and restrict their offerings going forward.

We have also seen the government address concerns over other tech companies and their capitalist intentions and actions, which has taken the form of questions over data security in Didi Global, the ride hailing app, and Meituan, the food service company.  After all, both of these companies are clarion calls for people to be independent, choosing their work schedule and effort, as opposed to toiling for a proper, state-owned firm.  Naturally, this is anathema to President Xi as he continues to remold the nation into his preferred view.

The latest attack has been on the private education industry, which while nominally teaching the approved curriculum, were clearly seen as an impediment to government control, and more importantly, the appropriate spread of communism.  Remember, the CCP rules the roost in China and President Xi is General Secretary of the Chinese Communist Party.  It was certainly dichotomous that an area of such immense social importance, that preached communism, would be offered by capitalist firms.

The takeaway here, though, is not that things are getting tougher for investors in China, but that history has shown that most financial crises start small and gather momentum.  While many of you may not remember the Asia crisis of 1997, it started as an issue solely confined to Thailand and the Thai baht.  Questions over the country’s ability to repay its creditors, especially as its USD reserves had shrunk and the dollar’s rally was becoming a major problem locally.  But Thailand is not a very large country from an economic perspective, and so it was initially thought this would amount to very little.  Within a month or two of the initial concerns, however, the entire region was in turmoil as it turned out virtually none of the countries there had sufficient USD reserves, and all had borrowed heavily in dollars and were having difficulty repaying those loans.  There was a huge swoon in markets, which ultimately led to Russia defaulting on its debt while Long Term Capital, a famed hedge fund of the time, wound up on the brink and was only saved by the Fed forcing the entire Wall Street community to put up money to save it.  (Ironically, Bear Stearns is the one bank that wouldn’t participate in that rescue and we know what happened to them 10 years later!)

Speaking of the GFC, this too, was seen as a minor problem at the start.  As the housing bubble inflated, the working assumption was that the entire national housing market could never fall all at once, so all of those mortgage-backed derivatives were created and sold as low risk, high return investments throughout the world.  When the first concerns were raised, none other than Fed Chair Bernanke explained that “…the troubles in the subprime sector on the broader housing market will likely be limited.”  We know how that worked out and of course, the problems quickly became global in nature and forced the first invocation of a new emergency program known as QE.

One last example of the ability of seemingly distant events to impact the entire global financial structure comes from China in 2015.  That summer, just 6 years ago, the PBOC surprised markets with a mini-devaluation of the yuan, about 2%, as a relief valve for an equity market that had started to come under pressure several months previously.  But once the PBOC acted, risk appetite disappeared and we saw a severe contraction in global equity markets, a huge bond rally and strength in the dollar as the haven of choice.

The point is that while you may consider the fact that the Chinese government is cracking down on companies that it considers to be ideologically impure, and that it will have nothing to do with your investments in the FANGMAN group of stocks, there is every chance that this action serves as the catalyst for, at the very least, a short-term price adjustment in equity indices around the world. After all, China’s growth has been a key pillar of the global growth scenario.  If that is slipping, there are likely to be problems everywhere.  Be warned and wary.

OK, on to today’s activity where the Chinese rout continues to be ignored by Japan (Nikkei +0.5%), but continues to pressure European indices lower (DAX -0.4%, CAC -0.3%, FTSE 100 -0.4%) as well as US futures, all of which are down around -0.2% at this hour.

Bond markets are a bit more uniform this morning, led by Treasury yields (-2.9bps) although European sovereigns have not rallied as much, with most seeing yield declines of roughly 1 basis point.  (As an aside, yesterday’s price action, which saw US equity markets ultimately rebound, saw Treasuries give up their early gains and close with slightly higher yields on the day.)

In the commodity space, oil is essentially unchanged on the day, as is gold, with neither moving even 0.1%.  Copper is the biggest mover, falling 1.0%, although there is lesser weakness in other base metals.  Agricultural products are mixed with both Soybean and Corn higher by 1.0% while Wheat has slipped 0.4%.

As to the dollar, on this broadly risk-off day, it is broadly higher.  In the G10 bloc, the commodity currencies are the worst performers (NZD -0.7%, NOK -0.5%, AUD -0.4%) while the rest of the bloc has seen less pressure.  Naturally, JPY (+0.25%) is bucking the dollar trend in this type of session.  In the emerging markets, ZAR (-0.7%) is the laggard as traders digest the post-riot relief act from the government and give it two thumbs down.  The next biggest loser is CNY (-0.35%), although at this point, I’ve already described the reasons capital is leaving the country.  Otherwise, most of these currencies are lower, but the movement has been on the order of -0.1% to -0.2%, so not very dramatic.  There is one outlier on the plus side, KRW (+0.4%) which seems to have been on the back of exporters selling dollars after yesterday’s won decline to its lowest level in almost a year.  However, if CNY continues to weaken, I believe KRW will ultimately follow it.

On the data front this morning we see Durable Goods (exp 2.2%, 0.8% ex transport) as well as Case Shiller House Prices (16.33%) and Consumer Confidence (123.8).  The real information overload starts tomorrow with the FOMC and on through the rest of the week with Q2 GDP and Core PCE.

The dollar is back in risk mode.  If equities continue to suffer, look for the dollar to remain bid.  If they rebound, the dollar is likely to soften by the end of the day.

Good luck and stay safe
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Jay’s Watershed

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The PMI data released
This morning show prices increased
As bottlenecks build
With orders unfilled
Inflation has shown it’s a beast

The question is, how will the Fed
Respond as they’re looking ahead
Will prices be tamed
Or else be inflamed
This may well be Jay’s watershed

Yesterday’s ECB meeting pretty much went according to plan.  There is exactly zero expectation that Lagarde and her crew will be tightening policy at any point in the remote future.  In fact, while she tried to be diplomatic over a description of when they would consider tightening policy; when they see inflation achieving their 2.0% target at the “midpoint” of their forecast horizon of two to three years, this morning Banque de France Governor Villeroy was quite explicit in saying the ECB’s projections must show inflation stable at 2.0% in 12-18 months.  In truth, it is rare for a central banker to give an explicit timeframe on anything, so this is a bit unusual.  But, in the end, the ECB essentially promised that they are not going to consider tightening policy anytime soon.  They will deal with the asset purchase programs at the next meeting, but there is no indication they are going to reduce the pace of purchases, whatever name they call the program.

One cannot be surprised that the euro fell in the wake of the ECB meeting as the market received confirmation of their previous bias that the Fed will be tightening policy before the ECB.  But will they?

Before we speak of the Fed let’s take a quick look at this morning’s PMI data out of Europe.  The most notable feature of the releases, for Germany France and the Eurozone as a whole was the rapid increase in prices.  Remember, this is a diffusion index, where the outcome is the difference between the number of companies saying they are doing something (in this case raising prices) and the number saying they are not.  In Europe, the input price index was 89, while the selling price index rose to 71.  Both of these are record high levels and both indicate that price pressures are very real in Europe despite much less robust growth than in the US.  And remember, the ECB has promised not to tighten until they see stable inflation in their forecasts 18 months ahead.  (I wonder what they will do if they see sharply rising inflation in that time frame?)

While the latest CPI reading from the Eurozone was relatively modest at 2.0%, it strikes me that price pressures of the type described by the PMI data will change those numbers pretty quickly.  Will the ECB respond if growth is still lagging?  My money is on, no, they will let prices fly, but who knows, maybe Madame Lagarde is closer in temperament to Paul Volcker than Arthur Burns.

Which brings us back to the Fed and their meeting next week.  The market discussion continues to be on the timing of any tapering of asset purchases as well as the details of how they will taper (stop buying MBS first or everything in proportion).  But I wonder if the market is missing the boat on this question.  It seems to me the question is not when will they taper but will they taper at all?  While we have not heard from any FOMC member for a week, this week’s data continues to paint a picture of an economy that has topped out and is beginning to roll over.  The most concerning number was yesterday’s Initial Claims at a much higher than expected 419K.  Not only does that break the recent downtrend, but it came in the week of the monthly survey which means there is some likelihood that the July NFP report will be quite disappointing.  Given the Fed’s hyper focus on employment, that will certainly not encourage tapering.  The other disappointing data release was the Chicago Fed National Activity Index, a number that does not get a huge amount of play, but one that is a pretty good descriptor of overall activity.  It fell sharply, to 0.09, well below both expectations and last month’s reading, again indicating slowing growth momentum.

This morning we will see the flash PMI data for the US (exp 62.0 Mfg, 64.5 Services) but of more interest will be the price components here.  Something tells me they will be in the 80’s or 90’s as prices continue to rise everywhere.  While I believe the Fed should be tapering, and raising rates too, I continue to expect them to do nothing of the sort.  History has shown that when put in these circumstances, the Fed, and most major central banks, respond far too slowly to prevent inflation getting out of hand and then ultimately are required to become very aggressive, à la Paul Volcker from 1979-82, to turn things around.  But that is a long way off in the future.

But for now, we wait for Wednesday’s FOMC statement and the following press conference.  Until then, the narrative remains the Fed is going to begin tapering sometime in 2022 and raising rates in 2023.  With that narrative, the dollar is going to remain well-bid.

Ok, on a summer Friday, it should be no surprise that markets are not very exciting.  We did see some weakness in Asia (Hang Seng -1.45%, Shanghai -0.7%, Nikkei still closed) but Europe feels good about the ECB’s promise of easy money forever with indices there all nicely higher (DAX +1.0%, CAC /-1.0%, FTSE 100 +0.8%).  US futures are higher by about 0.5% at this hour, adding to yesterday’s modest gains.

Bond markets are behaving as one would expect in a risk-on session, with yields edging higher.  Treasuries are seeing a gain of 1.3bps while Europe has seen a bit more selling pressure with yields higher by about 2bps across the board.

Commodity price are broadly higher this morning with oil (+0.1%) consolidating its recent rebound but base metals (Cu +0.4%, Al +0.7% and Sn +1.1%) all performing well.  All that manufacturing activity is driving those metals higher.  Precious metals, meanwhile, are under pressure (Au -0.5%. Ag -1.1%).

Finally, the dollar is doing well this morning despite the positive risk attitude.  In the G10, JPY (-0.3%) is the laggard as Covid infections spread, notably in the Olympic village, and concerns over the situation grow.  But both GBP (-0.25%) and CHF (-0.25%) are also under pressure, largely for the same reasons as Covid infections continue to mount.  The only gainer of note is NZD (+0.2%) which is the beneficiary of short covering going into the weekend.

In the emerging markets, ZAR (-0.55%) is the worst performer, falling as concerns grow that the SARB will remain too dovish as inflation rises there.  Recall, they just saw a higher than expected CPI print, but there is no indication that policy tightening is on the way.  HUF (-0.5%) is the other noteworthy laggard as the ongoing philosophical differences between President Orban and the EU have resulted in delays for Hungary to receive further Covid related aid that is clearly needed in the country.  The forint remains weak despite a much more hawkish tone from the central bank as well.

Other than the PMI data, there is nothing else to be released and we remain in the Fed’s quiet period, so no comments either.  Right now, the market is accumulating dollars on the basis of the idea the Fed will begin tapering soon.  If equities continue to rally, this goldilocks narrative could well help the dollar into the weekend.

Good luck, good weekend and stay safe
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Bears’ Great Delight

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As Covid renews its broad spread
Investors have started to shed
Their risk appetite,
To bears’ great delight,
And snap up more havens instead

Risk is off this morning on a global basis.  Equity markets worldwide have fallen, many quite sharply, while haven assets, like bonds, the yen and the dollar, are performing quite well.  It seems that the ongoing increase in Covid infections, not only throughout emerging markets, but in many developed ones as well, has investors rethinking the strength of the economic recovery.

The latest mutation of Covid, referred to as the delta variant, is apparently significantly more virulent than the original.  This has led to a quickening of the pace of infections around the world.  Governments are responding in exactly the manner we have come to expect, imposing lockdowns and curfews and restricting mobility.  Depending on the nation, this has taken various forms, but in the end, it is clearly an impediment to near-term growth.  Recent examples of government edicts include France, where they are now imposing fines on anyone who goes to a restaurant without a vaccine ‘passport’ as well as on the restaurants that allow those people in.  Japan has had calls to cancel the Olympics, as not only will there be no spectators, but an increasing number of athletes are testing positive for the virus and being ruled out of competition.

A quick look at hugely imperfect data from Worldometer shows that 8 of the 10 nations with the most reported new cases yesterday are emerging markets, led by Indonesia and India.  But perhaps of more interest is that the largest number of new cases reported was from the UK.  Today is ‘Freedom Day’ in the UK, where the lockdowns have ended, and people were to be able to resume their pre-Covid lives.  However, one has to wonder if the number of infections continues to rise at this pace, how long it will be before further restrictions are imposed.  Clearly, market participants are concerned as evidenced by the >2.0% decline in the FTSE 100 as well as the 0.45% decline in the pound.

While this story is not the only driver of markets, it is clearly having the most impact.  It has dwarfed the impact of the OPEC+ agreement to raise output thus easing supply concerns for the time being.  Oil (WTI – 2.75%) is reacting as would be expected given the large amount of marginal supply that will be entering the market, but arguably, lower oil prices should be a positive for risk appetite.  As I indicated, today is a Covid day.  The other strong theme is in agricultural products where prices are rising in all the major grains (Soybeans +0.6%, Wheat +1.4%, Corn +1.7%) as the weather is having a detrimental impact on projected crop sizes.  The ongoing drought and extreme heat in the Western US have served to reduce estimates of plantings and heavy rains have impacted crops toward the middle of the country.

With all that ‘good’ news in mind, it cannot be surprising that risk assets have suffered substantially, and havens are in demand.  For instance, Asian equity markets were almost universally in the red (Nikkei -1.25%, Hang Seng -1.85%, Shanghai 0.0%), while European markets are performing far worse (DAX -2.0%, CAC -2.0%, FTSE MIB (Italy) -2.9%).  US futures are all pointing lower with the Dow (-1.0%) leading the way but the others down sharply as well.

Bonds, on the other hand, are swimming in it this morning, with demand strong almost everywhere.  Treasuries are leading the way, with yields down 4.7bps to 1.244%, their lowest level since February, and despite all the inflation indications around, sure look like they are headed lower.  But we are seeing demand throughout Europe as well with Bunds (-2.4bps, OATs -2.0bps and Gilts -3.6bps) all well bid.  The laggards here are the PIGS, which are essentially unchanged at this hour, but had actually seen higher yields earlier in the session.  After all, who would consider Greek bonds, where debt/GDP is 179% amid a failing economy, as a haven asset.

We’ve already discussed commodities except for the metals markets which are all lower.  Gold (-0.35%) is not performing its haven function, and the base metals (Cu -1.7%, Al -0.1%, sn -0.7%) are all responding to slowing growth concerns.

Ahh, but to find a market where something is higher, one need only look at the dollar, which is firmer against every currency except the yen, the other great haven.  CAD (-1.2%) is the laggard today, falling on the back of the sharp decline in oil and metals prices.  NOK (-0.9%) is next in line, for obvious reasons, and then AUD (-0.7%, and NZD (-0.7%) as commodity weakness drags them lower.  The euro (-0.25%) is performing relatively well despite the uptick in reported infections, as market participants start to look ahead to the ECB meeting on Thursday and wonder if anything of note will appear beyond what has already been said about their new framework.  In addition, consider that weakness in commodities actually helps the Eurozone, a large net importer.

In the EMG space, it is entirely red, with RUB (-0.75%) leading the way lower, but weakness in all regions.  TRY (-0.7%), KRW (-0.7%), CZK (-0.55%) and MXN (-0.5%) are all suffering on the same story, weaker growth, increased Covid infections and a run to safety and away from high yielding EMG currencies.

Data this week is quite sparse, with housing the main theme

Tuesday Housing Starts 1590K
Building Permits 1700K
Thursday Initial Claims 350K
Continuing Claims 3.05M
Leading Indicators 0.8%
Existing Home Sales 5.90M
Friday Flash PMI Mfg 62.0
Flash PMI Services 64.5

Source: Bloomberg

The Fed is now in their quiet period, so no speakers until the meeting on the 28th.  Thursday, we hear from the ECB, where no policy changes are expected, although further discussion of PEPP and the original QE, APP, are anticipated.  So, until Thursday, it appears that the FX markets will be beholden to both exogenous risks, like more Covid stories, and risk sentiment.  If the equity market remains under pressure, you can expect the dollar to maintain its bid tone.  If something happens to turn equities around (and right now, that is hard to see) then the dollar will likely retreat in a hurry.

Good luck and stay safe
Adf

Progress, Substantial

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To everyone who thought the Fed
Was ready to taper, Jay said
‘Til progress, substantial,
Is made, no financial
Adjustments are reckoned ahead

If, prior to yesterday, you were worried that the Fed was getting prepared to taper its asset purchases, stop worrying.  It doesn’t matter what Dallas Fed President Kaplan, or even SF Fed President Daly says about the timing of tapering.  The only ones who matter are Powell, Clarida, Williams and Brainerd, and as the Chairman made clear once again yesterday, they ain’t going to taper anytime soon.

In testimony to the House Financial Services Committee Chairman Jay sent a clear message; nothing is changing until the Fed (read the above-mentioned four) sees “substantial further progress” on their twin goals of maximum employment and an average inflation rate of 2.0%.  Obviously, they have moved a lot closer on the inflation front, with many pundits (present company included) saying that they have clearly exceeded their goal and need to address that issue.  But for as much vitriol as is reserved for our previous president, both the Fed and Congress are clearly all-in on the idea that the 3.5% Unemployment Rate achieved during his term just before the pandemic emerged, which was the lowest in 50 years, is actually the appropriate level of NAIRU.

NAIRU stands for the Non-Accelerating Inflation Rate of Unemployment and is the economic acronym for the unemployment rate deemed to be the lowest possible without causing increased wage pressures leading to rising inflation.  For the longest time, this rate was thought to be somewhere in the 4.5%-5.5% area, but in the decade following the GFC, as policymakers pushed to run the economy as hot as possible, the lack of measured consumerinflation, despite record low unemployment, forced economists to rethink their models.  Arguably, it is this change in view that has led to the fascination with MMT and the willingness of the current Fed to continue QE despite the evident froth in the asset markets.  Of course, now those asset markets are not just paper ones like stocks and bonds, but also housing and commodities.

But that is the situation today, despite what appears to be very clear evidence that inflationary pressures are not just high, but longer lasting as well, the Fed has their story and they are sticking to it.  They made this clear to everyone last year with the new policy framework that specifically explains they will remain behind the curve on inflation because they will not adjust policy until they see real data, not surveys, that demonstrate growth is overheating.  Yet, given the Fed’s history, where they have often tightened policy in anticipation of higher inflation and thereby reduced growth, or even caused recessions, the market has learned to expect that type of response.  While I personally believe prudent policy would be to tighten at this time, I take Mr Powell at his word, they are not going to change anytime soon.  I assure you that of the dots in the last dot plot, Jay Powell’s was not one of the ones expecting interest rates to be 0.50% by the end of 2023.

One of the things that makes this so interesting is the difference of this policy with that of an increasing number of other central banks, where recognition of rising inflation is forcing them to rethink their commitment to ZIRP.  Earlier this week, the RBNZ abruptly ended QE and explained rates may rise before the summer is over.  Yesterday, the Bank of Canada reduced its QE purchases by another C$1 billion/week, furthering the progress they started in June, and Governor Macklem made clear that if inflation did persist, they would react appropriately.  Last night it was the Bank of Korea’s turn to explain that economic activity was picking up quickly and inflationary pressures alongside that which would make them consider raising the base rate at their next meeting.  Finally, all eyes are turning toward the BOE as this morning’s employment report showed that the recovery is still picking up pace and that wage growth, at a 7.3% Q/Q rise, is really starting to take off.  Market talk is now focused on whether the Old Lady will be the next to start to tighten.

In truth, the only three central banks that have made clear they are not ready to do so are the big 3, the Fed, ECB and BOJ.  The BOJ meets tonight with no changes to policy expected as they seem to be focused on what they can do to address climate change (my sense is they can have the same success on climate change as they have had on raising inflation, i.e. none).  Next week the ECB will unveil their new framework which seems likely to include the successor to the PEPP as well as their already telegraphed new symmetrical inflation target of 2.0%.  And then the Fed meets the following week, at which point they will work very hard to play down inflation in the statement but will not alter policy regardless.

As you consider the policy changes afoot, as well as the trajectory of inflation, and combine that with your finance 101 models that show inflation undermines the value of a currency in the FX markets, it would lead you to believe that the dollar has real downside opportunity vs. many currencies, just not the euro or the yen.  But markets are fickle, so don’t put all your eggs in that basket.

Turning to today’s activities, while Chinese equity markets performed well (Hang Seng +0.75%, Shanghai +1.0%) after Chinese GDP data was released at 7.9% for Q2, just a tick lower than forecast, and the rest of the data, Retail Sales and Fixed Asset Investment all beat expectations, the rest of the world has been much less exuberant.  For instance, the Nikkei (-1.15%) stumbled along with Australian and New Zealand indices, although the rest of SE Asia actually followed China higher.  Europe has been under pressure from the start this morning led by the DAX (-0.9
%) although the CAC (-0.75%) and FTSE 100 (-0.7%) are nothing to write home about.  US futures are also under pressure (Dow -0.5%, SPX -0.3%) although the NASDAQ continues to power ahead (+0.2%).

In this broadly risk-off session, it is no surprise that bond markets are rallying.  Treasuries, after seeing yields decline 7bps after Powell’s testimony, are down another 2bps this morning.  Similarly, we are seeing strength in Bunds (-1.4bps) and OATs (-1.1bps) although Gilts (+1.4bps) seem to be concerned about potential BOE policy changes.

On the commodity front, oil fell sharply after the Powell testimony and has continued its downward move, falling 1.8% this morning.  Gold, which had been higher earlier in the session is now down 0.15%, although copper (+0.6%) remains in positive territory.  At this point, risk has come under pressure across markets although there is no obvious catalyst.

It should not be surprising that as risk is jettisoned, the dollar is rebounding.  From what had been a mixed session earlier in the day, the dollar is now firmer against 9 of the G10 with NOK (-0.5%) the laggard although the entire commodity bloc is suffering.  The only gainer is the pound (+0.1%) which seems to be on the back of the idea the BOE may begin to tighten sooner than previously expected.

EMG currencies that are currently trading are all falling, led by ZAR (-0.7%), PLN (-0.5%) and HUF (-0.5%).  The rand is very obviously suffering alongside the commodity story, while HUF and PLN are under pressure as a story about both nations losing access to some EU funds because of their stance on issues of judicial and immigration policies is seen as a negative for their fiscal balances.  Overnight we did see strength in KRW (+0.6%) and TWD (+0.4%) with the former benefitting from the BOK’s comments on tightening policy while the latter saw substantial equity market inflows driving the currency higher.

Data today includes Initial (exp 350K) and Continuing (3.3M) Claims as well as Empire Mfg (18.0), Philly Fed (28.0), IP (0.6%) and Capacity Utilization (75.6%).  Yesterday’s PPI was also much higher than forecast, but that can be no surprise given the CPI data on Tuesday.  In addition, Chairman Powell testifies before the Senate Banking Panel today, with the same prepared testimony but a whole new set of questions.  (I did reach out to my Senator, Menendez, to ask why Chairman Powell thinks forcing prices higher is helping his constituents, but I’m guessing it won’t make the cut!)

And that’s the day.  Right now, with risk under pressure, the dollar has a firm tone.  But the background of numerous other central banks starting to tighten as they recognize rising inflation and the Fed ignoring it all does not bode well for the dollar in the medium term.

Good luck and stay safe
Adf

Like Tides in the Sea

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Though Jay and the FOMC
Refuse to accept it can be
Most prices worldwide
Can be certified
As rising like tides in the sea

Back in 2011, wedged between the GFC and the European debt crisis, the world witnessed the Arab Spring.  This was a series of populist protests throughout the Middle East and North Africa that were triggered by a confluence of events including a desire for more freedom and democracy by a group of populations that had been oppressed by kleptocratic and authoritarian rulers.  But one of the key issues that was apparent in each of the nations involved was the fact that inflation, specifically food prices, were rising rapidly and the impoverished citizenry of many of these nations could no longer afford to feed themselves or their families.  Ultimately, while there was much angst at the time about changes in ruling regimes and much hope that the siren song of freedom would be heard in heretofore brutal dictatorships, very little changed except the name of the authoritarian and kleptocratic leader.

From our perspective in the markets, the importance of this lesson is the potential impact that sharply rising food prices can have on both financial markets and political outcomes.  This appears topical given the rioting that has begun in two very different countries, Cuba and South Africa.  In Cuba, the list of complaints could have been written in Tunisia in 2011, as the people there are growing tired of the conditions under which they are forced to live by Raul Castro and Miguel Diaz-Canel, the heirs to the Fidel Castro regime.  The economy is in tatters and food shortages are rampant with little hope of change as long as the government remains in place.  South Africa, meanwhile, has had a different catalyst, the imprisonment of former president Jacob Zuma, but the conditions on the ground, where inflation is rising sharply, and growth has been lagging are not dissimilar to what precedes this behavior anywhere.

While two countries don’t yet make a trend, it will be important to pay close attention to other EMG nations who are experiencing the same types of pressures.  Remember, just because the Fed, ECB and BOJ are not ready to raise rates as they studiously ignore rising inflation, the same has not been true in a number of emerging markets like Brazil, Hungary and Mexico, whose central banks are responding to the obvious rise in price pressures by raising their policy rates.  Inflation is insidious as it impacts all that we do and eventually weighs on how we approach our everyday tasks.  Yesterday, the NY Fed released its monthly survey of inflation expectations and it jumped to 4.8% in the one-year category, the highest level since the survey began.  While inflation is frequently described as a monetary phenomenon, it is also a psychological one.  When you expect prices to rise, you tend to err on the side of buying things sooner rather than waiting.  And that behavior drives prices as well.  As the evidence of more persistent price rises continues to increase, there will come a denouement between the Fed and reality.  It is at that point that we could see some cracks in the current narrative of “stonks to the moon!”  Remember, being hedged ahead of a significant policy change makes a great deal of sense, so don’t wait until it’s too late.

Meanwhile, the market story today is one of a modest continuation of recent trends with no substantial outliers.  It appears investors are waiting for more information from the ECB on their new policy framework next week, as well as this morning’s testimony by Chairman Powell at the House of Representatives.

After yesterday’s late day rally in the US, Asian equity markets were all in the green (Nikkei +0.5%, Hang Seng +1.6%, Shanghai +0.3%) with the big data release Chinese trade numbers showing their exports climbed more than forecasts, clearly a positive sign for both China and global growth.  Europe has been a bit more mixed with extremely modest movement either side of unchanged and no story or data to discuss while US futures show the NASDAQ (+0.35%) continuing to power ahead although the other two main indices have done nothing.

Bond markets are rallying ever so slightly with Treasury yields lower by 0.8bps and similar declines throughout Europe (Bunds -0.7bps, OATs -1.5bps, Gilts -1.1bps).  As to commodity markets, they are mixed this morning with oil (+0.1%) marginally higher along with gold (+0.1%), while copper (-1.1%) is lagging.  The long-term trend for most commodities remains higher, although we continue to see short-term consolidation.

In the FX market, the most notable mover has been ZAR (-1.35%) which is continuing to suffer on the back of the rioting in the country and the likely negative impact it will have on the economy.  Other laggards in the EMG bloc are HUF (-0.5%), PLN (-0.5%) and MXN (-0.4%), as traders respond to differing issues in each nation.  Poland’s central bank has hinted that they will extend QE at a moment’s notice in the event the delta variant of Covid becomes a bigger problem, while Hungary seems to be suffering for its unwillingness to agree to a global corporate tax rate.  As to Mexico, the nominee for central bank governor, Arturo Herrera, explained he would not expect Banxico to begin a tightening cycle, despite the fact they have already raised rates once.  On the plus side, RUB (+0.4%) leads the way as traders anticipate future gains in the oil price.

In the G10 space, while the dollar is broadly firmer, the biggest movers have been GBP (-0.3%) and NOK (-0.3%), hardly the stuff of excitement.  Arguably, what we continue to see is short USD covering as positions remain overly short, albeit somewhat reduced from where things stood at the beginning of the quarter.

This morning, in addition to the Powell testimony, we see CPI (exp 4.9%, 4.0% ex food & energy), which ought to be quite interesting.  If the forecast is correct, it would be the first time that the Y/Y data fell since last November.  As well, if this is the case, Chair Powell will almost certainly point to the outcome in his comments today as a strong sign the Fed’s transitory inflation story playing out exactly as they anticipate.  Of course, a higher than expected print will require a bit more tap dancing on Powell’s part.

The FX market continues to consolidate with no large trend driving things currently.  Now that the relationship between the dollar and Treasuries has seemingly broken, traders are looking for new short-term drivers and waiting for clarification as to how the next trend will derive.  In other words, we are likely to continue to see somewhat choppy and directionless trading for the next several weeks unless we get something of real note.  So, paraphrasing Samuel Beckett, it appears we are ‘Waiting for Powell.”

Good luck and stay safe
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